Dollar In Bottoming Process

04/19/11 09:56:44 AM

by Alan R. Northam

Statistical analysis shows that UUP has started its bottom process but could eke out a new lower low or two before reversing upward.

Security: UUP
Position: N/A

The lower panel of Figure 1 shows the daily bar chart of the PowerShares DB US Dollar Index (UUP). This panel also shows a solid red extended downsloping 20-day linear regression line along with its upper and lower two sigma channels lines marking the downward rally from early February. In addition, the lower panel also shows a dotted red extended 20-day linear regression line along with its respective upper and lower two sigma channel lines. This more shallow downsloping linear regression line shows that more recently UUP has been descending at a slower rate signaling price deceleration, which normally occurs near the end of a trend.

FIGURE 1: UUP, DAILY. This chart shows the daily price chart in the bottom panel along with two 20-day linear regression trendlines and their respective upper and lower channel lines, the linear regression slope indicator in the top panel, the R-squared indicator in the second panel, and the relative standard error index (RSEI) in the third.

Graphic provided by: MetaStock.

The linear regression slope indicator in the top panel is an indicator of the price trend and a measure of momentum. When the indicator moves above its zero line, it signals the linear regression line is sloping upward, indicating an uptrend. When the linear regression slope indicator moves below the zero line, it signals when the linear regression line is sloping down, indicating a downtrend.

Momentum is also an indication of price acceleration or deceleration. When the linear regression line is above zero and sloping up, it is an indication that price is accelerating upward. When this indicator is above its zero line and sloping down, it is an indication of price deceleration in an uptrend. When the linear regression line is below zero and sloping down, it is an indication that price is accelerating in a downtrend. When this indicator is below zero and sloping up, it is an indication of price deceleration of the downtrend.

Note that in early March, the linear regression slope indicator started moving upward, signaling that the downward momentum in price had started to decelerate. I have added an upsloping green trendline to highlight this period of price deceleration.

The right end of the trendline shows that the linear regression slope indicator has broken down below the trendline. This is a signal that the descent in the price of UUP is again starting to accelerate.

The R-squared indicator also tells us two things. First, it tells us if there is a statistically significant trend, and second, it tells us the strength of the trend. A trend is considered statistically significant if the R-squared indicator is above its critical level. "Statistically significant" means how high the probability is that the trend will continue. To determine this probability, we point to the critical level. Differing critical levels determine different probabilities. The critical level used here determines whether there is a 95% probability of a trend continuing. Note that in early April, the R-squared indicator moved above the critical level, signaling that a 95% probability exists that the downtrend will continue.

The R-squared indicator also tells us the strength of the trend. Strength is measured from zero to 1, with zero indicating that the trend has no strength and 1 indicating that the trend is as strong as it can be. Note that this indicator has been moving in a downward direction since early March, signaling that the downtrend has been weakening. I have drawn a red downsloping trendline to highlight this period of a weakening trend. When looking at the right end of this downsloping trendline, note that it has now broken out above the trendline. This breakout signals that the price of UUP is once again starting to strengthen.

The relative standard error index (RSEI) is a measure of volatility. When the RSEI is below 0.2, it indicates low volatility, which normally occurs during a strong rally. When RSEI is above 0.8, it indicates high volatility. High volatility occurs near the end of a trend and is a warning of a trend reversal looming just over the horizon. Note that the RSEI is currently reading above 0.5 and below 0.8, indicating above-average volatility. This is an early warning that volatility is on the rise and once it crosses above 0.8, we should be on the lookout for a trend reversal.

In conclusion, price is currently decelerating indicating that a trend reversal is somewhere ahead. However, price is showing some signs of renewed acceleration. This new sign of price acceleration most likely indicates that a trend reversal will come somewhat later instead of sooner. Volatility is also starting a rise. Rising volatility is a sign of a price reversal ahead. These indicators warn that UUP is in the process of bottoming but could still eke out a new lower low or two before the reversal begins.

Alan R. Northam

Alan Northam lives in the Dallas, Texas area and as an electronic engineer gave him an analytical mind from which he has developed a thorough knowledge of stock market technical analysis. His abilities to analyze the future direction of the stock market has allowed him to successfully trade of his own portfolio over the last 30 years. Mr. Northam is now retired and trading the stock market full time. You can reach him at inquiry@tradersclassroom.com or by visiting his website at http://www.tradersclassroom.com. You can also follow him on Twitter @TradersClassrm.

	Garland, Tx
Website:	www.tradersclassroom.com
E-mail address:	inquiry@tradersclassroom.com

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Dollar In Bottoming Process

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